The recent problems surrounding Chinese drywall have beencompared to everything from a silent hurricane to the nextasbestos. But how do the costs really compare to a hurricane?

Are we more likely to see thequick settlement of claims typical of property damage fromhurricanes, or the long reporting lags and hard-fought legalbattles typical of asbestos claims?

Based on publicly available information and experience inestimating past construction-related torts, we estimate totaleconomic losses could fall in the $15 billion to $25 billionrange–numbers that rival some hurricanes but fall far short of theprice tag for asbestos.

Who will ultimately pay for the claims?

The share of the total that will fall to property and casualtyinsurers remains unclear. Early analysis suggests that potentialdefendants will face a host of coverage issues, and some have largeself-insured retentions which will limit recovery from commercialinsurers.

But asbestos, construction defect and even hurricane scenarioshave already taught private insurers how wrong initial thinking oninsured damages can be, underscoring the need for carefulmonitoring of claims experience as the drywall cases unfold.

INITIAL COST ESTIMATES

It has been widely reported that more than 500 million pounds ofChinese drywall was imported from China between the years 2004 and2007 and installed in approximately 100,000 homes nationwide. TheConsumer Product Safety Commission (CPSC) has now recorded 608reports of defective Chinese drywall in 21 states.

The most frequently cited issue is the smell of rotten eggsemanating from the drywall. Property damage claims include thefailure of air conditioning units and corrosion of copperpiping/coils, electrical wires and personal property such asfurniture, fixtures and jewelry.

Bodily injury claims allege respiratory problems, persistentcough, bloody noses, recurrent headaches, sinus infections, asthmaattacks and fatigue.

The costs of the defective Chinese drywall can be separated intofive categories: indemnity related to repairing the house, bodilyinjury from any health effects of the gases being emitted,plaintiffs' lawyers fees, defense lawyers fees and indirectcosts.

Of these, the costs of home repair are the moststraightforward.

Randy Noel, representing the National Association of HomeBuilders, recently testified before Congress that the cost ofremediation may range from one-third of the home's value to$100,000. While fewer than 100,000 houses may need remediation intheir entirety, the full number of homes containing Chinese drywallcan be used to estimate an upper boundary of the potentialcost.

According to the NAHB, the countrywide median value of new homessold between 2004 and 2007 was approximately $240,000. At one-thirdof the home value, the 100,000 homes with Chinese drywall wouldcost approximately $8 billion to repair. The cost estimate of$100,000 per home yields an even higher gross estimate of $10billion.

Bodily injury costs are more elusive at the moment. Chinesedrywall claims may have a similar fate as mold claims a decadeago–the causal link between defective drywall and adverse healtheffects may be difficult to establish. A lot will depend on theoutcome of the testing by the CPSC.

As we've seen with asbestos, any health findings established bya professional or government organization can have a dramaticeffect on the outcome of bodily injury lawsuits. If the CPSCconcludes that defective Chinese drywall poses a health problem, asignificant number of bodily injury claims may follow.

Even without official health findings, a homeowner with theright lawyer in the right venue could get a big settlement.Louisiana, where much of the defect drywall was installed and whereseveral cases have been transferred, is known as aplaintiff-friendly venue. Judges and juries might be even moresympathetic to plaintiffs hit by this "silenthurricane"–particularly plaintiffs who were already displaced byHurricane Katrina.

As for legal fees, we know from other construction defectexperience that they can be substantial, representing on average40-to-50 percent of the total claim cost.

Costs for Chinese drywall claims will vary depending on whetherthe claims are filed separately or as class-action claims. Theselegal fees will be significantly reduced if the constructionproject was covered by a wrap-up policy.

Nevertheless, it is likely homebuilders, and perhaps theirinsurers, will have to expend a considerable amount on legalexpenses. To make matters worse, legislation proposed in theLouisiana Senate would allow homeowners to sue not only for damagesbut also to recover attorney fees.

Indirect costs are composed of loss of use and potentialdiminution of home value. The indirect cost of the loss of use ofthe home will likely be borne by the party that is found liable forthe property damage. The diminution of home value is not allowed inmost states as a valid claim in a lawsuit, therefore it is likelythat diminution will be borne by the homeowners.

Our experience with tallying past claims relating toconstruction defects suggests that legal fees could pile on$5-to-$10 billion more of cost associated with Chinese drywall,with any bodily injury and indirect costs adding even more.

If we include the potential bodily injury damages and indirectcosts, a rough estimate of the total costs for the defectiveChinese drywall could be somewhere around $15-to-$25 billion. Whilethis is a far cry from the $81 billion of damage done by Katrina,according to the National Hurricane Center, it is well withincomparison of the top 10 most expensive hurricanes in history.

LATENCY & LIABILITY

Consider the comparison to asbestos.

Asbestos is unique among the mass torts for the propensity forcase law to morph and evolve over many decades. By contrast, mostmass torts are characterized by a growing number of claims,followed by a few landmark settlements that guide the conclusion ofthe remaining cases.

In this respect, we are more likely to see Chinese drywallfollow the more traditional mass tort pattern. Once we seeprecedents set for decisions on insurance coverage questions, suchas "your work" exclusions and pollution exclusions, we are likelyto see a more rapid conclusion to the Chinese drywalllitigation.

While it is too early to fully understand the latency, itappears that health complaints arise quickly after the onset of theodor. For southern states, this means we may already be seeing alarge number of bodily injury complaints. But in northern states,where less humidity may affect the speed of the off-gassingprocess, there may be a longer lag in the reporting of bodilyinjury claims.

The severity of health problems is still up in the air(literally), but most claimants can already point to the effects ofChinese drywall on their physical comfort, if nothing else.Additionally, there are already tests being run on the healtheffects of Chinese drywall, whereas with asbestos, several decadesof exposure passed before comparable health tests were run.

As legal battles play out, who will end up paying for thebillions of dollars of loss?

We are beginning to see the flood of claims, particularly inFlorida and Louisiana. Most of these claims are against a varietyof suppliers, drywall installers and homebuilders, in addition to acouple of manufacturers.

o Manufacturers. Unfortunately for homeownersand builders, the manufacturers of the faulty drywall are foreigncompanies and it has yet to be seen how they will be heldaccountable for their defective product. Precedent in other claimsagainst Chinese companies for defective products suggests there islittle chance of recovering damages.

o Suppliers. The supplier is not covered undermost construction wrap-up policies and will, therefore, stand alonein a lawsuit.

In tendering claims to commercial general liability insurersunder individual policies, they may face definitional issues. Forinstance, if drywall gives off unpleasant odors, that fact may notby itself establish property damage. However, the claimants allegethat the off-gassing of sulfur compounds corrodes soft metals inthe homes, which does qualify as property damage.

Suppliers must also reckon with the policy's pollutionexclusion. State law varies on whether indoor pollution events (asopposed to industrial pollution) are within the reach of theexclusion.

o Homebuilders. Homebuilders in recent yearshave been taking larger and larger portions of their risk, whichcould leave them with substantial exposure to paying claims beforesatisfying per-occurrence or even aggregate retentions.

Additionally, recovery from insurance depends on the outcome ofcoverage questions surrounding pollution and "your work"exclusions.

o General contractors. Contractors still inbusiness may have some exposure to the claims. In fact, sincegeneral contractors tend to have well-developed insurance programsin comparison to subcontractors, they may find themselves thetargets of lawsuits as plaintiffs' attorneys seek out deep pockets.They are subject to some of the same policy restrictions ashomebuilders.

o Subcontractors. In the building frenzy afterhurricanes, not all subcontractors were licensed and some have goneout of business. Those with sufficient claims-made insurancecoverage may not only find themselves with some direct exposure,but their general contractors or builders may seek to tap intotheir coverage under additional insured status.

In the end, the homeowners will be left absorbing any costs theyare not able to recoup from other parties. Insurers have alreadydenied coverage under the homeowner policy, citing the pollutionexclusion, according to Florida press reports.

It may take years to determine who will pay for these costs,with non-wrap and claims-made policies creating additionalcomplexities. Insurers and self-insureds will need to continuouslymonitor their exposures. (See accompanying sidebar on "LessonsLearned.")

The construction economy will also affect the outcome. If smallbuilders, subcontractors and suppliers cannot weather the currentand future stormy times, they may not have insurance policies torespond or the ability to pay their self-insured liabilities.

Our collective ability to predict the ultimate costs ofdefective Chinese drywall is limited until various industry andlegislative studies are completed and courts make some preliminaryrulings. However, as with any construction defect problem, weshould be able to create some scenarios by sensitivity-testingfrequency, severity, reporting patterns and payment patterns.

As insurance professionals, we should examine our company'sexposures by looking at the risks we insured or self-insured. Weshould make sure management understands potential exposure issuesand is not caught unawares.

Rachel Boles ([email protected]) isa Towers Perrin consultant in San Francisco, and RonaldKozlowski ([email protected])is a Towers Perrin principal in Hong Kong. Both are Fellows of theCasualty Actuarial Society.